http://www.mckinsey.com/global-themes/china/five-myths-about-the-chinese-economy

http://www.bbc.com/news/business-34040679

http://www.tradingeconomics.com/india/imports

https://www.quandl.com/collections/economics/gdp-as-share-of-world-gdp-at-ppp-by-country

http://www.mckinsey.com/global-themes/china/five-myths-about-the-chinese-economy

http://www.worldbank.org/en/country/china/overview

http://www.bbc.com/news/business-34040679

Predictions of deepening economic woes are plentiful. Here are five arguments against the pessimism.

A widely held Western view of China is that its stunning economic success

contains the seeds of imminent collapse. This is a kind of anchoring bias,1which

colors academic and think-tank views of the country, as well as stories in the

media. In this analysis, China appears to have an economy unlike others—the

normal rules of development haven’t been followed, and behavior is irrational at

best, criminal at worst.

There’s no question, of course, that China’s slowdown is both real and important

for the global economy. But news events like this year’s stock-market plunge

and the yuan’s devaluation versus the dollar reinforce the refrain, among a

chorus of China watchers, that the country’s long flirtation with disaster has

finally ended, as predicted, in tears. Meanwhile, Chinese officials, worried about

political blowback, are said to ignore advice from outside experts on heading off

further turmoil and to be paranoid about criticism.

My experience working and living in China for the past three decades suggests

that this one-dimensional view is far from reality. Doubts about China’s future

regularly ebb and flow. In what follows, I challenge five common assumptions.

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1. China has been faking it

A key tenet of the China-meltdown thesis is that the country has simply not

established the basis for a sustainable economy. It is said to lack a competitive,

dynamic private-enterprise structure and to have captured most of the value

possible from cheap labor and heavy foreign investment already.

Clearly, China lacks some elements of a modern market economy—for example,

the legal system falls short of the support for property rights in advanced

countries.2Nonetheless, as China-economy scholar Nicholas Lardy recently

pointed out, the private sector is vibrant and tracing an upward trend line. The

share of state-owned enterprises in industrial output continues to drop steadily,

from 78 percent in 1978 to 26 percent in 2011.3Private industry far outstrips the

value added in the state sector, and lending to private players is growing rapidly.

In fact, much of China’s development model mirrors that of other industrializing

and urbanizing economies in Asia and elsewhere. The high savings rate, initial

investments in heavy industries and manufacturing, and efforts to guide and

stabilize a rapidly industrializing and urbanizing economy, for example,

resemble the policies that Japan, South Korea, and Taiwan followed at a similar

stage of their development. This investment-led model can lead to its own

problems, as Japan’s experience over the past 20 years indicates. Still, a

willingness to intervene pragmatically in the market doesn’t imply backwardness

or economic management that’s heedless of its impact on neighboring

economies and global partners.

Furthermore, China’s reform initiatives4since 2013 are direct responses to the

structural changes in the economy. The new policies aim to spur higher-value

exports, to target vibrant emerging markets, to open many sectors for private

investors, and to promote consumption-led growth rooted in rising middle-class

incomes. Today, consumption continues to go up faster than GDP, and investors

have recently piled into sectors from water treatment to e-commerce. These

reforms are continuing at the same time China is stepping up its anticorruption

drive, and the government hasn’t resorted to massive investment spending (as it

did in 2008). That shows just how important the reforms are.

2. China’s economy lacks the capacity to innovate

Think tanks, academics, and journalists alike maintain that China has, at best, a

weak capacity to innovate—the lifeblood of a modern economy. They usually

argue as well that the educational system stomps out creativity.

My work with multinationals keen on partnering with innovative Chinese

companies suggests that there’s no shortage of local players with a strong

creative streak. A recent McKinsey Global Institute (MGI) study describes areas

where innovation is flourishing here.5Process innovations are propelling

competitive advantage and growth for many manufacturers. Innovation is at the

heart of the success of companies in sectors adapting to fast-changing consumer

needs, so digital leaders like Alibaba (e-commerce) and Xiaomi (smartphones)

are emerging as top global contenders. Heavy investment in R&D—China ranks

number two globally in overall spending—and over a million science and

engineering graduates a year are helping to establish important beachheads in

science- and engineering-based innovation. (See “Gauging the strength of

Chinese innovation.”)

3. China’s environmental degradation is at the point of no return

To believe this, you need to think that the Chinese are content with a dirty

environment and lack the financial muscle to clean things up. OK, they got

things wrong in the first place, but so did most countries moving from an

agrarian to an industrial economy.

In fact, a lot that’s good is happening. Start with social activism. A documentary

on China’s serious air-pollution problems (Under the Dome), by Chai Jing—a

former journalist at China Central Television (CCTV), the most important state-

owned broadcaster—was viewed over 150 million times in the three days after it

was posted online, in March 2015. True, the 140-minute video, which sharply

criticizes regulators, state-owned energy companies, and steel and coal

producers, was ultimately removed. But the People’s Daily interviewed Chai

Jing, and she was praised by a top environmental minister.

China is spending heavily on abatement efforts, as well. The nation’s Airborne

Pollution Prevention and Control Action Plan, mandating reductions in coal use

and emissions, has earmarked an estimated $277 billion to target regions with

the heaviest pollution.6That’s just one of several policy efforts to limit coal’s

dominance in the economy and to encourage cleaner energy supplies. My

interactions with leaders of Chinese cities have shown me that many of them

incorporate strict environmental targets into their economic master plans.

4. Unproductive investment and rising debt fuels China’s rapid growth

To believe this, you would have to think, as many skeptics do, that the Chinese

economy is fundamentally driven by overbuilding—too many roads, bridges,

and buildings.7In fact, as one economist has noted, this is a misperception created

by the fact that the country is just very big. An eye-popping statistic is

illustrative: in 2013, China consumed 25 times more cement than the US

economy did, on average, from 1985 to 2010. But adjusted for per-capita

consumption and global construction patterns, China’s use is pretty much in line

with that of South Korea and Taiwan during their economic booms.8

China’s rising debt, of course, continues to raise alarms. In fact, rather than

deleveraging since the onset of the financial crisis, China has seen its total debt

quadruple, to $28.2 trillion last year, a recent MGI study found.9Nearly half of

the debt is directly or indirectly related to real estate (prices have risen by 60

percent since 2008). Local governments too have borrowed heavily in their rush

to finance major infrastructure projects.

While the borrowing does border on recklessness, China’s government has

plenty of financial capacity to weather a crisis. According to MGI research, state

debt hovers at only 55 percent of GDP, substantially lower than it is in much of

the West. A recent analysis of China’s financial sector shows that even in the

worst case—if credit write-offs reached unprecedented levels—only a fairly

narrow segment of Chinese financial institutions would endure severe damage.

And while growth would surely slow, in all likelihood the overall economy

wouldn’t seize up.10

Finally, the stock-market slide is less significant than the recent global hysteria

suggests. The government holds 60 percent of the market cap of Chinese

companies. Moreover, the stock market represents only a small portion of their

capital funding. And remember, it went up by 150 percent before coming down

by 40.

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Rumors drive the volatility on China’s stock exchange, often in anticipation of

trading by state entities. The upshot is that the direct impact on the real economy

will most likely be some reduction in consumer demand from people who have

lost money trading in shares.

5. Social inequities and disenfranchised people threaten stability

On this one, I agree with the bears, but it’s not just China that must worry about

this problem. While economic growth has benefited the vast majority of the

population, the gap between the countryside and the cities is increasing as urban

wealth accelerates. There’s also a widening breach within urban areas—the rich

are growing richer.11

Urban inequality and a lack of access to education and healthcare are not

problems unique to China. People here and in the West may find fruitful

opportunities to exchange ideas because the pattern across Western economies is

similar. Leaders of the central government have suggested policies to improve

income distribution and to create a fair and sustainable social-security system,

though implementation remains a matter for localities and varies greatly among

them.

In short, China’s growth is slower, but weighing the evidence I have seen, the

sky isn’t falling. Adjustment and reform are the hallmarks of a stable and

responsive economy—particularly in volatile times.

About the AuthorsJonathan Woetzel is a director in McKinsey’s Shanghai office, as well as a director of the McKinsey Global Institute. A version of this article was previously published on Forbes.com, on October 5, 2015.

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China's Economy Is Not Really The Problem For U.S. MarketsOnce again, disappointing economic news out of China has set investors’ nerves on edge. Although the actual decline of China’s Purchasing Manager Index was not all that large, a significant improvement had been expected. Thus, hopes for a turn in that economy were dashed. Realistically, however, China is not the problem. The real worry is that global slowing—and specifically the decline of industrial production in the United States—will drag us into recession. Broad leading indicators for most global economies show no strong evidence of an impending recession, but the weakening industrial activity has left an anxious undertone. Yet when we take a deeper look at the factors that have weighed on U.S. production, we find that the outlook for industrial activity is probably better than most investors fear.

The collapse of energy exploration and development played a major role in the decline of industrial production in the United States in 2015. Over most of the year, new supply continued flowing into the markets as projects that were already under development were completed and began producing. In 2016, energy investment and the price of oil should finally stabilize. While there is little hope that the energy sector will rebound any time soon, industrial reports will benefit as energy declines no longer hide growth in other areas.

World trade levels were also worrisome in 2015, as international trade volume declined 4% from December through May, according to

data from the Central Planning Bureau in the Netherlands. Slowdowns of that magnitude have rarely occurred unless international economies were sliding into recession. In contrast, it appears that the 2015 trade slump may have been different. The 2015 decline seems to have been a short-term correction more than the beginning of a major decline. Trade volume grew an annualized average of just 2% from 2011 through 2013, but jumped 5% in 2014. That seems to have been too far ahead of the sustainable trend. The sharp slowing over the first half of 2015 appears to have corrected the 2014 excess. From May through October of last year, trade started growing again and looks to be back on track for 2016. While U.S. exporters still face the challenges of a strong currency, they should nonetheless benefit from a renewed growth of world trade.

Finally, the U.S. consumer failed to provide as much support for the economy in 2015 as many economists thought they would. Consumers saved roughly $88 billion dollars in gasoline savings over the last year. With disposable incomes growing and little apparent risk of recession, economists anticipated that consumers would spend the money saved on gasoline for other things. But consumers do not seem to have fully redeployed those energy savings. Admittedly, healthcare costs have become problematic for many families, as they face healthcare plans requiring them to pay more costs out of pocket. In addition, college tuition and other essential costs continue to pressure many household budgets. Consumers may, therefore, be more cautious about spending windfalls than they were in past cycles. As incomes continue to grow and the energy savings mount, more of the improving household cash flow could still go into other spending. That would be a significant positive for the production side of the economy.

Since the world is clearly awash in surplus manufacturing capacity, no one expects breakout growth in 2016. We would note, however, that global excess has been much harder on countries like China, which needs to shift its economy away from its strong reliance on exports and continued investment in additional capacity. While growth will likely remain sluggish in most economies around the world, those with larger domestic consumption contributions may face fewer problems than the Chinese economy.

What does this mean for investors? Outside the trends in trade and industrial production, there has been little evidence of major economic slowing in most economies around the world. That is critical for investors. Since equity markets typically do not fall sharply outside recessions, the trend of industrial production this year could be pivotal for the investment markets. If production can begin to expand—even modestly—fears that the rest of the economy will be dragged into recession should calm. As we have seen, several factors suggest that industrial production in the United States should improve. If global economies can continue to grow, 2016 should be a reasonably solid year for equity investors.